Over the past four weeks we have added several new tools to the Trading China Tracker. The focus is on risks associated with investments in U.S.-listed Chinese stocks. It is absolutely crucial for any China investor to thoroughly assess the risks before making an investment decisions. These tools should work as a starting point for your research.

Safety/Risk Model

We have introduced a two-stage safety/risk model for U.S.-listed Chinese stocks. Stage One is based on publicly available information, Stage Two requires independent research and can not be automatized.

For every stock we are covering on Trading China, you can now find an additional score card for the Safety/Risk Model (Example: CVVT). All the data is compiled into a percentage score that indicates the safety level according to our algorithm. Please keep in mind that this is not meant to be the ultimate truth - it is based on Stage One of the model only - but it will provide a good starting point for your research into the validity of the reported financials, corporate governance issues, and the possibility of fraud.

The following data is compiled on this page and used to determine the safety score for this particular stock:

The Safety Score is translated into a Safety Label which spans a range from "Extreme Risk" (Score under 30%), over "High Risk" (30% - 50%), "Moderate Risk" (50% - 75%), "Moderate Safety" (75% - 90%), to "High Safety" (Score over 90%). Ideally, all the stocks you want to invest your money in - as in "buy and hold" and contrary to short-term trades - should be labeled with "Moderate Safety" or higher. For all other names you are strongly advised to do your homework before taking any position. Please keep in mind that, with the exception of Account Receivables data, the safety score has nothing to do with reported financials.

From our coverage universe, the companies with the highest safety score are Ctrip.com International (CTRP), E-House (China) Holdings (EJ), and 3SBio Inc. (SSRX). A total of 24 Chinese stocks passed the Safety/Risk Test with a "High Safety" label, and another 20 names scored with "Moderate Safety". Among those 44 companies you will find only two that went public via Reverse Merger, Cogo Group (COGO) and American Oriental Bioengineering (AOB).

A total of 146 stocks failed the test with a "High Risk" or "Extreme Risk" label. The vast majority of them are Reverse Mergers or SPAC deals, but you will find a good number of regular IPOs in that group as well. The overall picture is terrifying. At the time of writing, nine companies do not have an auditor, and trading in 15 Chinese stocks is currently halted by the exchanges (not counting recently delisted CCME and CAGC). 37 companies have not filed their last quarterly or annual reports, some disappeared completely (CGDI, JADA), others filed a "going dark" Form 15 (GHNA, ENHD). I repeat, it is crucially important that you do your own research before taking a position in any of the "High Risk" or "Extreme Risk" stocks. If you don't have the time or means to do that, you should probably avoid this whole group of stocks.

We have added tracker pages for all auditors of Chinese companies in the Trading China database. You can find information of all past and current clients of this auditor, if the firm was dismissed or resigned, the exact dates of the engagement/dismissal, and a screen of all related companies with their year-to-date performance. These tracker pages can be accessed from the auditor trails of each individual company within the China Tracker (Example: KPMG).

Another new screen is a chronological list of all auditor changes, starting with the most recent ones. The data is taken from Form 8-K or Form 6-K SEC filings only, not from press releases or other sources. When you click through the pages of this screen you will find that the number of auditor resignations has exploded since the start of 2011.

8 Comments:

Have you backtested your safety ratings at all? In other words, if you went back to before LFT, CCME, etc. were halted, how would they rank? I would think LFT would have done quite well - Big 4 auditor, tons of analysts, etc. But still highly unsafe, in the end.

Yes exactly - LFT would have scored very well. The LFT fraud made all the big names on Wall Street look like fools. This company had the best of references, Tier One underwriters, analysts, investors, etc. - yet if you read Deloitte's resignation letter you can see that the likely fraud was committed by senior management in collusion with Chinese banks and probably other institutions. 11 of the biggest Wall Street firms, incl. Goldman and Deutsche, had a buy rating on the stock when it got halted. No kind of "model" can detect this kind of fraud, only thorough individual due diligence can. Kudos to Andrew Left for that.

CCME had a "moderate risk" rating before it blew up. It lacked many of LFT's positives, like going public, coverage, history as a public company, shareholder dilution etc., but it still ranked in the top 20% of all Chinese non-IPO stocks according to the model. The clues that might have given away the CCME fraud (growth rates, margins) are very industry specific and can not be automatized in a safety/risk model.

Nice post which Please keep in mind that this is not meant to be the ultimate truth it is based on Stage One of the model only but it will provide a good starting point for your research into the validity of the reported financials, corporate governance issues, and the possibility of fraud. In which The exception of Account Receivables data, the safety score has nothing to do with reported financials. Thanks a lot for posting this article.

Exquisitely professional thoughts. I merely hit upon this web site and desired to enunciate that I've definitely delighted in reckoning your blog articles or blog posts. Rest assured I'll subsist college-paper.net pledging to your RSS and I wish you write-up after much more shortly